My Bull Case For AEM Holdings (AWX)

When the new management (Lok Wai San & Albert Ng) took over in 2011, they began a multi-year corporate restructuring process and invested heavily in R&D at the expense of short term pain (FY12,13,14 net loss was -S$1.38m, -S$4.07m, and -S$34.6m respectively).

In light of recent events, it seems that the efforts of management has paid off and AEM is ready to rise from the ashes. The company turned in a profit of S$5.7m for FY15 and now possess tremendous growth opportunities over the next 10 years. This is due to its new flagship product (from years of R&D) known as the “high-density test handler”.

At S$0.85 per share, AEM is valued at only S$36.3m. With a ttm P/E of 4.35x, I believe this company is greatly undervalued and has the potential to be a multi-bagger.

The Business

AEM designs and builds manufacturing equipment for the semiconductor industry. It has two core businesses, Equipment Systems Solutions (ESS) and Precision Component Solutions (PCS). For FY2015, ESS contributed 86% in revenues while PCS contributed 12%. The “high-density test handler” is under ESS. Sales are mainly in USD while expenses are in SGD and MYR.

Co-developed with Intel (a key customer of AEM) since 2011, the “high-density test handler” significantly reduces the cost of manufacturing semiconductors by testing multiple chips in a single machine compared to individual chip testing in multiple machines. Furthermore, AEM owns the intellectual property rights and is allowed to sell the test handler to other customers besides Intel. This means that AEM is the only company in the world able to produce the “high-density test handler”.

After 5 years of R&D and collaboration with Intel, AEM has just begun its commercialisation phase for its new test handlers, is already ramping up production, and increasing engineering headcount. While the sale capital equipment is a low margin business, there will be recurring income in the years ahead from selling consumables used with these machines.

Aside from the core businesses, on July 21 2016, AEM took a 21% stake in Novoflex (privately-held co.). Novoflex is “essentially an outsourced assembler and tester of chips that are embedded in credit cards and debit cards”. However, the underlying potential of Novoflex is in its intellectual property; the technology to produce low-cost SIM cards for mobile phones. Management says that production of the new SIM cards will commence very shortly and that it will be disruptive and revolutionise the prepaid industry. Synergies will arise as AEM will produce the new capital equipment for Novoflex.

According to Gartner, semiconductor CAPEX is forecasted to improve after two years of lacklustre growth. This certainly bodes well for AEM.

The Management

Loke Wai San – Non-Exec Chairman & Non-Excec Director: Founder and Managing Director of a private equity fund adviser Novo Tellus Capital Partners. The Novo Tellus Fund 1, L.P., is the sole member of Orion Phoenix which has a 27.31% stake in AEM. This means Novo Tells Capital Partners has the largest stake in the business.

Charles Cher – Exec Director & CEO: Joined AEM in Apr-14. Formerly the CEO of ASTI Holdings Ltd. and CEO of Advanced Systems Automation Ltd, has more than 25 years of global semiconductor and corporate management experience. Owns 275,500 shares (0.63%) of AEM.

Management have been aggressive with their corporate restructuring since taking over AEM. For instance, in FY14 they disposed of their subsidiary, MCT, which was running losses for several years, to fund the growth of their core equipment and services business. In FY15, they exited from the stagnant plating business to further support its growth in its core businesses.

Management has also been aggressively conducting share buybacks, which signal their confidence in the growth narrative of AEM. As at 28 Dec 2016, the last time AEM bought back shares, it held 2,347,500 treasury shares (5.2% of total issued shares) vs. the maximum 4,403,943 authorised for purchase (9.76% of total issued shares). At end-FY15, it held only 1,101,500 treasury shares (2.44% of total issued shares).

The highest price paid for the share buyback was S$0.85 on 13 Dec 2016 (and 28 Dec 2016). This provides investors with a good price/support level at which AEM can be thought to be undervalued by management.

The Financials

Revenues and Net Profit has turned around since FY15.

Cashflow from Operations turned positive in LTM Ending 30 Sep 16 while CAPEX requirements has declined substantially over the years since the new management took over in 2011.

Total Debt/Equity has been steadily decreasing, insulating it from a rising interest rate environment. ROE has since turned around to reach above 25% in FY15. Net Income Margins, as expected from a capital equipment business, have been in the low teens (10-12%).

Note: As at 30 Sep-16, AEM had debts of S$106k with cash and cash equivalent of S$8.4m. However, due to its large working capital requirements (i.e. high levels of current liabilities), the company is NOT in a net cash position.

4th Jan 17 Update: AEM’s order-book has grown by more than 10-fold since start of FY14 to beginning of FY17. From Mar-16 to Jan-17, AEM’s order-book more than trebled from S$24.5m to S$84.5m. This acceleration of growth in order-book underpins the tremendous earnings growth potential for AEM in coming years, or at least in 2017.

The Valuation

Given the successful turnaround and stellar growth prospects of AEM, its valuations are surprisingly low. I believe if AEM continues to deliver strong earnings growth, the market will wake up to this undervalued gem.

Using hist. P/E multiple of 9.6 (lower than UMS’ 9.8x), which was the P/E multiple of AEM when it IPO-ed in 2000, the business could potentially be worth S$1.85 (118% upside). Market Cap of AEM will be S$79m (similar to AEM post-IPO Market Cap of S$74m). No earnings growth assumed.

Aggressive

Given the accelerating growth in sales order-book and positive industry tailwinds; assuming earnings growth of 50% in FY17 and a P/E multiple of 9.6, AEM could potentially be worth S$2.78 (227% upside). Market Cap of AEM will be S$118.6m.

Note: None of the scenarios include the potential earnings contributions from Novoflex.

The Bottomline

Early phase of ramping up production of its “high-density test handlers”

Owns intellectual property rights to said product

Positive industry tailwinds

Management with significant stake in the business

Frequent & Consistent Share Buybacks

Revenue, Net Income, and Cashflow from Operations have turned around/positive

Customer concentration and cancellation risk: One customer (Intel) accounted for 80% of its total revenue in FY15. Any order cancellation or postponement by Intel will severely affect AEM’s profitability. However, such a scenario is very unlikely due to the dominant position of Intel (largest chip-maker in the world) in the semiconductor industry and the long-term strategic relationship between the 2 companies.

Kenny Chia

34 thoughts on “My Bull Case For AEM Holdings (AWX)”

I like this stock too. Good and growing order book, low debt, strong insider buyback etc and even the tailwinds are good – USD/SGD appreciating. Only concern I have is the over-reliance on Intel, but hey, Intel is doing okay too.

I am concerned on this company. Small and over reliance on 1 major customer. Also US tech seems to be correcting after the trump bull run. Low volatility and held by private equity fund which make price movement easy. Wonder why sgx did not query on the price surge. But I may punt to ride the wave built up since snow is looking at new price target after his vested interest(@what price) and hope he is not here to distribute…..happy new year.

Hi Mr Chia,
Tq for your informative write up.
I suppose AEM has to set up onsite service support teams for their equipment sold.
Any idea how are the costs of these service support teams being financed?
What are the consumables n services they hope to earn?
Wishing you a Happy n Prosperous New Year.

You’re welcome and a happy new year to you too.
1) The costs of the service support teams are booked under “Staff costs” in the income statement. Since AEM has negligible debt, the teams are probably financed using internal resources (i.e. cash or cashflow from operations).
2) There’s opportunity to sell recurring high-margin consumables after the sale of the test handlers, though I doubt it would contribute meaningfully to the top and bottomline of AEM for FY17 [new test handlers still in early stages of commercial high(er) volume production].

What is your take in recent report announcement? I notice the outlook forecast is good, 1H2017 is expected to achieve what is FY16 result. Management also mention looking at expanding capacity in 2H2017.

I think the management is doing a fine job in communicating their growth story and confidence in their announcement (i.e. higher dividends,bullish profit guidance). Now all they need to do is deliver on their forecasts. I am interested as to what they meant by expanding capacity, would probably ask them during the AGM.

Beyond FY17, just have to look at what Intel is doing, are they expanding or contracting? I believe we still have at a few years (2-3) to go because AEM has JUST went into commercial production in FY16. Intel is also on an expansion mode (Semi-conductory industry turning up too), so theres definitely room for growth beyond FY17.

Yes I am still bullish on AEM. In fact, I bought alot more over the last 2 trading days after the results were announcement. So yes, at current prices, I believe it is still a cheap. The general market has not yet discovered this undervalued gem.

Thanks for the information. Do you have more information about the High density test handler?

I manage to search in YouTube and only find MIRAE test handler M500HT and other brands. Is it the same?

Another thing I tried to understand is, for the past AEM have sold about 700 old version test handlers? As the new high density test handler can do multiple test, does this means the HDTH units may be only one third of the 700 units sold? Which is about 233units multiply by few millions per units? Revenue stream good for another 3 years as they ramp up production?

I’m afraid not, I am not an expert on the HDTH. With regards to guesstimating their potential revenues, it would be better to get more concrete inputs (i.e. average selling price and replacement ratio), if not the value would be of little use. Perhaps it would be a good idea to ask such questions in the upcoming AGM.

I would think that the market potential is much larger now vs. back then (with 700+ machines sold) due to the technological superiority of the HDTH. AEM can start selling to other major chip manufacturers besides Intel once they have increased their capacity.

Hi, the bonus share issue will improve the liquidity of the company. Allowing investors to buy and sell its shares more easily. All things being equal, liquid shares are more valuable than less liquid ones. So AEM will benefit from this exercise.

Thanks 🙂 Given current available information, S$1.85 is a sweet spot for myself. Any further positive announcements (increase order book, higher interim dividends, etc) should get it to that level. Could reach before end of this year IF all goes well.

As per recent report 6.5mil PBT for 1H2017 and expanding for 2H2017, conservatively assuming 10mil NPAT equates to 23.3cents EPS. Based on historical PE 10x, I would think 2.33 as a target for now, depending on 2H2017 result, it could be higher if result are better. @ 2.33 market cap is about 100mil, I think it is still relatively small compare to peer, which is few hundred millions. What do you think?

“Moderate
Using hist. P/E multiple of 9.6 (lower than UMS’ 9.8x), which was the P/E multiple of AEM when it IPO-ed in 2000, the business could potentially be worth S$1.85 (118% upside). Market Cap of AEM will be S$79m (similar to AEM post-IPO Market Cap of S$74m). No earnings growth assumed.”

I am just being conservative on my estimation. Always better to be positively surprised to the upside. Yes, it is quite easy for AEM to reach S$100m market cap IF FY17 EPS is S$0.23. That would depend on whether the management can deliver what they said/forecasted. Should management over deliver, given the fact that the order book is still growing, we could see S$2.33 or higher by early next year.

This is possible considering the FACT that there is NO analyst coverage (besides the non-rated report by KGI). I don’t think the mass retail investors have noticed this company yet. Big Institutional investors/funds probably have not taken a stake due to the lack of liquidity and small market capitalisation.

Congratulations on discovering this GEM, share price has came close to a bagger since your coverage.

I did a quick look at AEM and UMS holdings, I do have some questions looking at their latest FY16 figures and would like to know what’s your take on both – in comparison.

Given the recent 2 years, AEM’s growth looks impressive but the balance sheet looks frail with a marginal 1.6M in retained earnings and a negative (1.7M) in CF from ops, will this be an on going concern? Why and why not?

While UMS seems to be in a stronger financial position in the above stated despite poorer profitability.

Thank you, a series of positive events occured much earlier than expected so I am lucky in that sense. AEM is JUST turning around so the balance would look bad, but it will only improve here on out. Negative CF from ops is mainly due to higher working capital from higher orders for its new products so not much concern there. UMS is a dividend play while AEM is a turnaround-fast grower play. It depends what the investor is looking for (yield vs. capital gain) and comfortable with. I understand the dynamics of AEM much more than UMS, so I’d still pick AEM.

It will depend on whether the management will meet and/or exceed its profit guidance for 1HYFY17 and how many more research houses initiate coverage on the company. Now only CIMB has a rated coverage. With the increasing discovery of AEM by the market, I believe the prospect of a takeover by a larger competitor (Cohu?) is more and more likely. Market Cap of AEM is currently only S$80m despite the huge run up. I do think more upside is ahead for this company.

Thank you for your detail report, without it I wouldn’t have bought AEM.
1. Reading the CEO message in just received AR, it stated in 4th paragraph, “EXECUTE this multi year program”, Chairman also mention “At the START of a multi-year implementation program”
2. About half of rev from sales of kits and spares, half is machine sales. Assuming this ratio (about same range for past two year) maintain about the same for future multi year implementations, margin should improve?
3. Foot note 7. Relating to Smartflex, “the investment partnership can provide both immediate and long term benefits…”

I think the stock still have room to rally… what do you think of the message management trying to send across?
Thank you once again!

Glad that you found the report useful. Congrats on your profitable trade 🙂

I am still in the midst of digesting AEM’s AR. From what I’ve gathered, the management is trying very hard to narrow the valuation gap by spreading the good news of its successful turnaround and growth trajectory [via Non-deal roadshows too]. Regarding the points you’ve brought up, I think it’ll be better if we sought more details & clarification during the AGM itself.

Valuations wise, AEM’s market cap is S$95m, which is still very small. I agree that the stock still has room to go up. However, I am now more interested in how the Chairman will exit this investment. Maybe he can make a deal with Intel or Cohu to have a takeover offer for entire company? That would certainly expedite the entire process of waiting for Mr. Market to uncover its fair value.

Good morning, once again thank you TLS. did you saw the news of order increased to 152mil to be delivered in FY2017? I did a brief calculation on EPS, should be in the range of 23.3 cents based on 65mil outstanding shares. Hurray!

I’ve sold off my position in AEM in April. I wrote about it in “http://www.thelittlesnowball.com/aem-holdings-awx-revisited-2/”
I believe most of the growth has already been priced in. There’s still some upside left, but the risk to reward is no longer appealing, in my opinion.